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The IPO disruptor: the revolution of special purpose acquisition companies (SPACs)

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The IPO disruptor: the revolution of special purpose acquisition companies (SPACs)

Special purpose acquisition companies (SPACs) may seem like a recent phenomenon, but they have been around for a long time. Infect “Blank check” companies became very popular in the 1980s before changes in rules & regulations ceased their operation. To understand how modern-day SPACs are different from Blank check companies of the 1980s, let’s see what regulations restricted their operation. To protect investors from Blank check companies, SEC came out with the following rules:

  • Restricted purpose: the company must have a well-defined singular purpose for making an acquisition. It can not alter its purpose after the acquisition.
  • Time restrictions: the acquisition must be completed within 18 months of the company’s formation.
  • Use of proceeds: the IPO proceeds must be kept in an escrow account invested in riskless products and returned if the deal does not get through.
  • Shareholder approval: Shareholder approval is required in two stages. Once when the target company is identified and again when acquisition terms are agreed upon.
  • Opt-out provisions: shareholders may choose to redeem their shares; in that case, the company will have to return their original investment net of any costs and with interest earned.

These regulations made it almost impossible to run a Blank check company. But SPACs are created around these restrictions. A SPAC is initiated by sponsors who bring some sort of expertise that may be related to any specific industry, deal-making skills, etc. In return for their expertise, these sponsors receive a significant stake in the company (20% approx.) at a subsidized price. Unlike Blank check companies, SPACs provide multiple benefits to public investors. Investors enjoy the right to disapprove of any potential acquisition by SPAC and get their money back. They can also choose to Opt-out and redeem their investment. At the end of the period (usually 18 months to 2 years), SPAC is wound up. It is said to be successful if the acquisition deal goes through; in that case, the target private company becomes public. If the acquisition is disapproved by shareholders or for any reason it does not get through, then SPAC returns the capital to investors.


SPACs as an alternative to IPOs

The process of IPO is built around Investment bankers. Here a private company planning to go public hires a banker or a syndicate of bankers, prepares a prospectus, bankers determine the IPO pricing, and also provide a guarantee of that price in return for an underwriting fee. IPOs have been the most dominant process of going public for decades, but recently many companies have started questioning the validity of IPOs. IPO is a very costly and time-consuming process; it comes with high disclosure requirements, and the entire role of bankers, from setting prices to selling the issue to the public, has been questioned in the recent past. Bankers quite often misprice companies. Infect empirical evidence suggests that banking valuations are almost always biased on the downside as they try to play safe. This downside bias in valuation makes the banking price guarantee less attractive. And it raises a fundamental question: are the fees paid to bankers by target companies justified or not?

In light of these factors, Direct market listing has become popular in the last few years as a potential alternative to IPOs. In a direct listing, an upcoming public company bypasses the banking system and sells its shares of stock directly to public investors. Thus, the company saves underwriting fees and may get better pricing. The problem with direct listings is that of recognition; less popular private companies may not be able to influence public investors without the backing of a prominent investment banker.

Perhaps the most promising alternative to IPOs is a Special purpose acquisition company (SPAC). SPAC go public and raises the capital first; thus, they are more time efficient and can take advantage of the short-term market up movements. While the disclosure requirements for SPACs are on the same lines as IPOs, SPACs have more freedom to spin stories and make projections. Finally, SPACs take advantage of sponsors’ expertise in negotiating better prices.

The above-mentioned benefits of SPACs should be considered along with their costs. Issuance of shares to sponsors at subsidized prices causes dilution for other investors. Besides, sponsors enjoy much higher control over the deal-making process, which may benefit them disproportionately. Also, there is a potential conflict of interest between SPAC investors and issuing companies as SPACs market themselves to be a more cost-effective way of going public; simultaneously, they promise higher returns to their investors.

The effect of SPAC: Who benefits on whose costs

Let’s discuss the costs and benefits of SPACs for each party involved:

  • Sponsors: Sponsors seem to be at a clear advantage. They receive a significant stake in SPAC at discounted prices; if the deal is closed, they get a handsome return, and if the deal does not get through, they get their money back as investors. Apart from these, they have much higher control over the operations of the SPAC, which they may use for their disproportionate benefit.
  • Investors in SPECs: Empirical evidence suggests that from the time SPAC goes public to the time it announces a merger deal, investors enjoy a healthy return on their investments. But most often than not, investors lose money on a SPAC-merged entity.
  • Owners of issuing companies: Private companies may benefit from a faster process of going public through SPACs. And may be able to negotiate better prices. Still, the potential dilution effect and negative historical returns of post-merger entities make SPACs a less attractive way of going public for issuing companies.


Specs have become quite popular in the recent past as an alternative to IPOs. Bankers-led IPO process has been the most dominating medium for going public, but now it is showing its age. And the good thing is that we are seeing new alternatives emerging. Whether it is IPOs or SPACs, going public is easier in up markets and difficult in cold times. In the recent past, due to fiscal and monetary stimulations, stock markets have been on the rise, and SPACs have taken advantage of that. SPACs will come under test during the falling markets. Do SPACs have the potential to replace IPOs completely, or both IPOs and SPACs can survive together? Share your thoughts.

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